Which Funds Are in Katrina's Way?

August 31, 2005

By Palash R. Ghosh As Hurricane Katrina smashed into the coast of the Gulf of Mexico on Aug. 29, its effects could be felt as far away as Wall Street. Crude oil futures briefly surged over $70, energy stocks rose, and insurance issues sank. After the damage is assessed and debris cleared, what will Katrina's long-term impact on the markets be? And how can mutual-fund investors respond to Mother Nature's fury?

While it's still too early to accurately evaluate Katrina's full scope, the storm was clearly devastating to the Gulf region. We at Standard & Poor's believe three industries in particular -- energy, insurance, and airlines -- will be on investors' radars (see BW Online, 8/30/05, "Counting Katrina's Costs").

In the Gulf, about 95% of oil production and 88% of gas production was shut down as a result of Katrina, and it may take weeks to evaluate the extent of the damage. As a result, U.S. Energy Secretary Samuel Bodman has approved a loan of oil from the Strategic Petroleum Reserve.

GAS LEAKS. However, the biggest concerns may lie on the refined-products side, with about 13% of U.S. refining capacity still shut down as a result of the storm, as well as locally produced natural gas, according to Tina Vital, an energy equity analyst at Standard & Poor's.

The sentiment was felt in the market as well. Nymex WTI oil prices have risen 5.6%, to $69.81, since last Friday, but Nymex gasoline has climbed 28%, to 247.45 cents, and natural gas is up 19%, to $11.66.

Some Gulf producers, such as ConocoPhillips (COP), and some Gulf refiners, such as Valero Energy (VLO), may have escaped the path of the storm, but Vital believes power outages, flooding, and damage to nearby state infrastructure will be the biggest hurdles to restoring operations.

INSURANCE PREMIUMS. With the Colonial Pipeline, which transports refined products, down at least until the weekend, and U.S. gasoline inventories already low going into the Labor Day weekend, Vital believes we may soon see $3 gasoline prices at the pump and expects the upward price impact of Katrina will be felt for months. Vital maintains her positive outlook on integrated oil and refinery stocks.

Some oil-service and disaster-relief companies may also benefit from the storm. For example, Standard & Poor's Equity Research Services upgraded Cal Dive International (CDIS), a provider of marine-contracting services around the world, including wells in the Gulf of Mexico, to buy from hold.

Many investors will likely focus on insurance, particularly the property and casualty sector as well as the reinsurance group. According to early projections (which vary greatly), Katrina could cost the insurance industry as much as $26 billion in claims, making it the most expensive storm in history. Hurricane Andrew in 1992 racked up a bill of about $16 billion (unadjusted for inflation). In 2004, four hurricanes that slammed into Florida and the East Coast resulted in a combined $23 billion payout by insurers.

PRICING QUESTIONS. Disasters of this type sometimes benefit insurance stocks in the long term, since investors expect these companies to significantly boost their premium rates. But Tom Davis, financial-services analyst at Loomis Sayles, doesn't think that will happen. "The insurance industry had nearly a decade of pricing declines, but now we're in a better pricing environment, having witnessed a four-year period of significant rate increases," he says. "As such, it's probably unlikely that we'll see insurance stock prices shoot sharply higher."

Davis noted that the four hurricanes that hit the Southeast last year "didn't trigger an industry-wide upward movement in pricing." Insurance equities, he said, have performed "pretty well over the past six to nine months largely because their earnings are now coming through from the pricing and rate increases enacted over the past few years, not as a result of last year's big hurricanes."

On Aug. 29, after Katrina hit land, S&P insurance-industry equity analyst Cathy Seifert reiterated her neutral outlook on the property and casualty sector. "Insurance stocks typically strengthen in hurricane season amid the belief that storm losses will drive up premium rates," she said. "But if Katrina causes serious damage to oil rigs in the Gulf, oil prices could spike. We believe that would offset any potential upside to insurance stocks from the belief that premium rates would strengthen."

CLAIM ABSORPTION. Seifert added that Allstate (ALL) and Hartford Financial Services Group (HIG), each ranked strong buy, remain her top picks in the sector.

For Allstate, Seifert says she doesn't think the damage will be as bad as originally feared. "Based on our analysis of market share, we think Allstate is highly exposed to the area, in terms of home insurance. However, because this storm hit low-lying areas, flooding may account for a greater percentage of total losses than in other catastrophes. The typical homeowner's policy excludes damage caused by flooding," she says.

Davis agrees. "Allstate will probably take a pretty good hit from Katrina, but given their national presence, they'll be able to absorb these claims fairly readily across the country," he says. "On the other hand, the small regional carriers which write policies in just the Gulf of Mexico states could be in big trouble, depending upon their reinsurance programs."

REINSURANCE RISKS. Reinsurers, which provide insurance to the insurers themselves, may pose a bigger risk as they bear most of the costs associated with catastrophic claims. In essence, the primary insurance outfits spread their risk among the reinsurers.

"The reinsurers could face considerable losses in the event of a large enough catastrophe," Davis says. "However, while reinsurers face larger potential losses than primary insurers, they do so with less frequency than the primary insurance firms." Seifert remains cautious on reinsurance amid concerns over pricing and reserve adequacy, she says.

Perhaps no industry has been more hurt by persistently high crude oil prices than the struggling airlines, which witnessed a spate of airport closures and cancelled flights as a result of Katrina. Higher fuel prices may further damage the carriers' profitability and fragile financial health.

RETAIL DIP. Already on the verge of bankruptcy, Atlanta-based Delta Air Lines (DAL) sank 2.3% the day Katrina hit land and plunged another 5.8% on Aug. 30. Northwest Airlines (NWAC), also attempting to stave off bankruptcy, dropped 1.5% on Aug. 29 and another 5.1% on Aug. 30. U.S. Airways Group, which is already in bankruptcy, plunged 13.3% on Aug. 29.

Katrina is also expected to hurt the retail sector across the board, due to likely higher gasoline prices, says John Derrick, co-portfolio manager of the Holmes Growth Fund (ACBGX). "Consumer spending power would probably diminish," he predicts. "In fact, even before the hurricane, we have seen some weak sales numbers from Wal-Mart (WMT) and Gap (GPS), among others, over the past month. Now, higher gasoline prices would intensify this situation."

Other industries with a significant presence in Mississippi, Alabama, and Louisiana -- like casinos, tourism, and riverboat gambling -- will probably also suffer disruptions and loss of local revenues. "We expect Hurricane Katrina to hurt gaming results from the Gulf Coast and New Orleans areas," says Thomas Graves, lodging and gaming analyst at Standard & Poor's, who maintained a neutral opinion on casino stocks.

LOSING STREAK. Companies he believes will be affected include Harrah's Entertainment (HET), which operates a casino in New Orleans, plus two casino/hotels on the southern Mississippi coast; and MGM Mirage (MGM), which runs a casino/hotel in Biloxi, Miss. However, Graves added, most of these companies' operations are located outside of the southeastern U.S.

Here's a sampling of mutual funds and ETFs that have significant exposure to certain major oil stocks that are likely to be impacted by Hurricane Katrina:

Fund/ETF

Oil Stock

Exposure*

iShares DJ U.S. Energy Sector Index Tr (IYE)

Exxon Mobil (XOM)

22.9%

S&P Select Energy SPDR Fund (XLE)

Exxon Mobil (XOM)

19.1%

iShares S&P Global Energy Sector Index Tr (IXC)

Exxon Mobil (XOM)

19.0%

iShares DJ U.S. Energy Sector Index Tr (IYE)

Chevron Corp (CVX)

18.1%

S&P Select Energy SPDR Fund (XLE)

Chevron Corp (CVX)

12.5%

iShares Morningstar Large Val Fund (JKF)

Exxon Mobil (XOM)

11.5%

Dreyfus Premier Tax Managed Growth Fund/A (DTMGX)

Exxon Mobil (XOM)

9.0%

Dreyfus Premier Structured Large Cap Val A (DLVAX)

Exxon Mobil (XOM)

8.2%

Dreyfus Premier Core Equity Fund/A (DLTSX)

Exxon Mobil (XOM)

8.0%

And here are mutual funds and ETFs that have significant exposure to certain major insurance stocks that are likely to be affected by the storm. One in particular, the $191 million Fidelity Select Insurance (FSPCX), represents an almost pure play on the industry.